KIM: Should investors ‘friend’ Facebook’s massive IPO?

Facebook’s upcoming initial public offering is the most highly anticipated since Google’s IPO in 2004. At the top end of the predicted range of $28 to $35 per share, Facebook would raise up to $13.6 billion and sport a market value just shy of $100 billion.

The company’s prospectus (available online here) gives investors their first chance to “look under the hood” of the social networking site. Among the revelations:

As of March 31, Facebook had 901 million monthly active users (someone who used the site within the last 30 days), an increase of 33 percent from a year earlier. The United States accounted for 169 million of them, up only 15 percent. And the company estimates that 60 percent of Internet users here already are on Facebook, so growth should slow.

Attracting new users and increasing the “frequency of engagement” for existing users will be critical going forward. This will lead to growth in “ads delivered” and advertising sales, which accounted for 87 percent of revenue in the most recent quarter. But growth in the number of users who access Facebook via mobile app—more than half the total—does not help in this regard, since they are typically not shown ads.

The prospectus’s section on “risk factors” runs to 22 pages. Facebook is almost totally dependent on third-party advertisers, none of which have long-term commitments. Internet gamer Zynga, which plans to reduce its reliance on Facebook, accounted for about 15 percent of the company’s revenue in the most recent quarter. And it faces competition from heavyweights including Google, Microsoft and Twitter.

Savvy investors know they can’t make an intelligent assessment of the investment merit of an asset without accounting for its price. As you can see in the table, Facebook, Google and fellow tech giant Apple all are growing, but Apple’s and Google’s profits are growing faster than revenues.

Facebook’s costs are rising faster than revenue, shrinking margins. So, it seems difficult to justify the premium a $100 billion market value implies.

NASDAQ recently shortened the waiting period for a company to join the NASDAQ 100 Index to just three months, so it’s no coincidence Facebook decided to list there. And technology fund managers are going to be under intense pressure to own it, regardless of valuation.•

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Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or mickey@kirrmar.com.